Ahead of the Curve

The lending environment is undergoing a worrying change. Funds that European direct lenders have raised but not yet deployed are at an all-time high and banks in most Western-European jurisdictions have renewed lending following years of reticence after the global financial crisis, leading to increased competition amongst lenders in the small and medium enterprise (SME) market.

Related Articles

Related Categories

Ian Fraser finds that Scottish independence would create a host of complications for newly created cross-border pension funds. But neither the London nor Edinburgh governments seem willing to engage with the issues

Politicians and civil servants on both sides of the Scottish-English border have so far been burying their heads in the sand about the risks Scottish independence would pose for the pensions industry – including cross-border, defined benefit schemes, public sector schemes and the state pension. A break-up of the UK is a real possibility dependent on the outcome of a referendum on Scottish independence due to be held on 18 September 2014.

The Institute of Chartered Accountants of Scotland (ICAS) fired the opening salvo in an ongoing pensions war of words in April when it published ‘Scotland’s Pensions Future: What Pensions Arrangements Would Scotland Need?’. The provocative 20-page report asked a string of legitimate questions but what grabbed headlines was the warning that, under EU law, any defined benefit or hybrid scheme with members on both sides of the Scottish-English border would be classed as ‘cross-border’ and have to be fully funded as soon as Scotland became independent.

Under Europe’s Institutions for Occupational Retirement Provision (IORP) Directive, all cross-border schemes would have to remain fully funded at all times and conduct annual – as opposed to triennial – actuarial evaluations. These requirements have “major cost and cash flow implications for employers,” said ICAS, which urged the UK, Scottish and EU governments to enter talks with each other and stakeholders and to agree on transitional arrangements as soon as possible. However, since ICA’s call five months ago, very little has been done.

The Department for Work & Pensions is refusing to engage on the matter. Apparently it does not wish to be seen to giving credence to the prospect of Scottish independence.Some see this as irresponsible, since it is the UK government, and not the Scottish one, which has the locus to speak to the EU. ICAS executive director David Wood added: “The issue would have as much impact on the rest of the UK as it would on an independent Scotland.”

The devolved administration of first minister Alex Salmond has adopted a Canute-like stance, consistently downplaying the issue, offering little but reassuring platitudes and implying that some sort of state guarantee could be offered to schemes that found themselves in difficulties.

Speaking at First Minister’s Questions in May, Salmond said there would be “no difference” to the time companies would have to make good their pension deficits under independence. He also said the Scottish government would examine the three solutions proposed by ICAS – one of which involved splitting existing schemes into separate ones to cover Scotland and rest of the UK. Scotland’s finance secretary John Swinney later blamed Westminster policy for pushing many DB schemes into deficit, highlighting chancellor Gordon Brown’s 1997 ‘pensions raid’, when advance corporation tax was abolished. “The pensions issues that the country faces today have not been created by independence – they have been created by the Union,” he said. Swinney also pledged that pensions would be “properly and fully funded” under independence: “We would use the wealth of Scotland to support our commitments.” Meanwhile, so-called cyber-Nats have taken to the internet to rubbish warnings about pensions in a post-independence Scotland as “scaremongering” and “Project Fear”. Salmond’s government has promised a pensions white paper and it is expected to be released in November.

Margaret de Valois, head of pensions at accountants Mazars, says: “Either Swinney has failed to understand the issues or he is just playing a political game. Maybe he realises he will lose the referendum and therefore that it is not going to be tested this time.” The Institute of Fiscal Studies has warned that an independent Scotland would be unwise to make state pension guarantees, as they would add to the fiscal challenges posed by an ageing population.

According to Ronnie Bowie, senior partner at actuarial consultants Hymans Robertson, the risks are all too real. “If Scottish independence required the creation of separate DB schemes for Scottish and rest-of-UK registered employees the disaggregation costs could be in the billions. It would probably bring DB schemes to an end in Scotland – other than in the public sector,” Bowie comments. “UK and European pensions law is a minefield. Poor implementation could risk costs running into the billions of pounds, and this is something that would have to be shouldered by employers.”

Mammoth taskThere are currently some 6,316 defined benefit pension schemes in the UK, according to the Pension Protection Fund. Of these, some 5,000 are in deficit, and the total shortfall is estimated by the NAPF at be £300bn (€349bn). It is not known exactly how many of these would be cross-border schemes if Scotland were to become independent but it could be as high as two-thirds. “Any attempt to unbundle and separate out UK pension schemes into new Scottish and non-Scottish schemes would be a mammoth task taking years to plan, execute and complete,” says Ian Gordon, partner at law firm Pinsent Masons, noting that ICAS paper only “scratches the surface”.

The Better Together campaign, a cross-party group that believes Scotland should remain in the UK, issued two press releases on 29 July 2013. The first identified a £700m annual black hole in the SNP’s plan for the state pensions while the second said independence would jeopardise the pensions of 36,000 university staff in Scotland, since universities would have to fill the £9.8bn hole in the Universities Superannuation Scheme on independence. There were also warnings that UK-wide charities would have to divert hundreds of millions of pounds away from good causes and into their pension schemes. David Davison, who sits on ICAS’s pensions committee and runs actuarial firm Spence & Partners, said some charities would have to close.

However Rachel Holmes, lecturer in accounting at Napier University in Edinburgh dismissed the IORP requirements as a “scare story”. “What seems to have been ignored is that the majority of public sector schemes are unfunded and possible independence would not have the same impact on them.” Holmes, who previously worked for Scottish Amicable, JP Morgan and Ernst & Young, believes it would be more productive to work towards solutions than constantly hyping up problems.

Future of regulationIn June, the Scotland Office, a department of the UK government, listed 200 organisations, including departments and quangos, which would have to be replicated by an independent Scotland in the event of secession. Eight were directly related to pensions, including the Pensions Regulator and the Pensions Protection Fund. So far, the Scottish government has not been explicit on its plans for pensions regulation and insurance. Most experts assume that an independent Scotland would stick with the status quo for at least some time post-independence to give itself time to put alternative structures in place.

Bowie believes that in an independence scenario the two governments would reach a compromise whereby Scotland “rented services” from the Brighton-based Pensions Regulator. He says the existing PPF might be able to continue, but may have to be sub-divided into ‘Scottish’ and the ‘rest-of-the-UK’ sub-funds. However, Bowie warns that this could result in very large ‘Scottish’ pension funds, such as those of RBS and HBOS, dominating the Scottish segment of the PPF and calling into question whether the remaining Scottish funds could support a default of one of their larger counterparts. “Scottish pension protection arrangements would likely require a Scottish government guarantee unless a pooling arrangement with the UK PPF could be agreed with the UK government,” says ICAS’s assistant director for charities and the public sector, Christine Scott.

The ICAS report also highlighted issues facing state and public sector pensions – currently underfunded to the tune of £60bn in Scotland – in the event of Scottish independence. Scottish LGPS funds would be relatively unaffected, since they are currently funded and administered solely within Scotland and therefore scheme assets and liabilities would remain in situ. However, unfunded schemes like the NHS in Scotland and Scottish Teachers’ Superannuation Scheme could be more problematic.

On state pensions, Holmes says “delicate negotiations and calculations” would be required ahead of a lump sum repatriation of NICs paid out by eligible Scots over the years.” She believes that pertinent bodies, including the DWP and Treasury, ought to be entering into negotiations now. De Valois said the most difficult issue for state pensions, which cost £7.4bn a year in Scotland, is establishing who “belongs” to Scotland. An Institute for Fiscal Studies briefing note published on 30 July warned that Scotland’s more rapidly ageing demography could bring “somewhat burdensome” future welfare costs. The IFS does not believe the “slightly more generous” envisioned by the SNP could be sustained in the long term without tax rises or spending cuts

The solution, in the event of independence, could be for both Scotland and rest of the UK to seek a carve-out from the EU pensions Directive that would enable cross-border schemes with deficits to be make these good over a period of say five years,” Scott says.“At the very least one would expect occupational defined pension funds and sponsoring employers to be doing some contingency planning – even if they believe that a ‘no’ vote the most likely result.

Bowie concludes: “If that big bill is to be avoided in the event of Scottish independence, it’s going to require a lot of patience and goodwill on both sides of the border. And the only real winners are likely to be pensions lawyers and other professional advisers, including actuarial consultants.”